- Productive efficiency is concerned with the optimal method of producing goods; producing goods at the lowest cost.
- Allocative efficiency is concerned with the optimal distribution of goods and services.
Example: An economy could be productively efficient in producing large numbers of boots – but if they were all for the left foot, it would be allocatively inefficient as no one would benefit from these low production costs.
Definition of productive efficiency
This is defined as producing goods and services for the lowest cost. Productive efficiency is said to occur on the production possibility frontier. On the PPF curve, it is impossible to produce more of one good without producing less of another.
In the diagram below, if you are at point A, you can’t produce more services without foregoing goods.
Point D in the graph is productively inefficient because you can produce more goods or services without an opportunity cost.
Lowest point on SRAC Curve
Productive efficiency also involves producing at the lowest point of the short run average cost curve (where MC cuts the bottom of the SRAC curve.)
Usually, productive efficiency refers to the short run (i.e. producing at the lowest point of SRAC curve) But if can also refer to producing at the lowest point on the Long Run Average Cost curve LRAC i.e. benefiting from economies of scale.
Related to productive efficiency is the concept of technical efficiency. Technical efficiency specifically refers to the optimal combination of inputs, i.e. using the minimum combination of labour and capital to produce a certain quantity of goods.
Allocative Efficiency definition
Allocative efficiency is quite different and is more concerned with the distribution and allocation of resources in society.
Allocative efficiency looks at the marginal benefit of consumption compared to the marginal cost. Allocative efficiency will occur at an output when marginal benefit (price) = marginal cost.
We can say:
- Allocative efficiency occurs where price = marginal cost (MC)
- Monopolies are often said to be allocatively inefficient because they are able to set the price higher than marginal cost. See: Monopoly
Related to allocative efficiency is the concept of social efficiency. Social efficiency makes a point of taking into account all externalities so we can try and equate social marginal benefit and social marginal cost.
Which is most important productive or allocative efficiency?
There would be no point in being productively efficient if all resources are diverted to making guns. We could be producing on a production possibility frontier but, if it is all guns, society would not have enough food or health care.
An anecdote from the Soviet Union under Communist days tells how factories were given targets to produce certain quantities of goods. They often did this with great vigour and were productively efficient, but, often they were producing goods which weren’t needed by society. There is a story that one factory made left-hand boots that nobody wanted, so at the end of the day they would efficiently burn them and the next day start again! They were productively efficient but not allocatively efficient.
However, productive efficiency is still important. If goods are produced at a lower cost it enables society to have a better trade-off and enable the scope for people to consume more goods and services.
12 thoughts on “Productive vs allocative efficiency”
please send me material on ” the factors affecting allocative efficiency. i will be very thankful
Can we have allocative efficiency without productive efficiency?
Firms could produce products that people need and that would maximize marginal benefit. However, due to a variety of reasons the firms may not be efficient in producing these products. Some reasons include X-inefficiency (in the case of big firms), managerial problems, and wage problems.
Hope it’s clear!
Q.2 Is PPF illustrations of productive and allocative efficiency?
If all the resources were completely used for the “goods” production as shown in the PPF (first diagram). Then it would be productively efficient or not.
Is allocative inefficiency always greater than one?
does the economics efficiency have different graphs
For a production point to be productively efficient, does it must first be allocatively efficient?
Not necessarily, a firm can be productively efficient without being allocatively efficient. That is to say that a firm may produce at the lowest possible production cost but not produce the amount of the product that is desirable by consumers [the amount can be higher than necessary or lower than necessary] – if it is higher than necessary then the firm is able to export the product as they will have surplus, however if the amount is lower than necessary then the market is said to be inefficient in the allocation of resources to desired goods.
I would argue that it is not possible to achieve allocative efficiency without being productively efficient. Productive efficiency is achieved at minimum AC, while allocative efficiency is when P=MC. MC will cross AC at the lowest point. If it doesn’t cross at the AC’s lowest point, the condition of LONG-RUN equilibrium of P = AC = MC will not be achieved. In addition, if the production is not efficient, the marginal benefit would not be optimal. The X-inefficiency happens when there is lack of incentives, the firm will not be technically efficient, therefore its production is not productively efficient. In the long run, the gap is widening and it is impossible to achieve BOTH efficiencies. Hope it is clear!
As long as resources are fully employed and every firm in the economy is producing Its output using the best available resources and the level of technology . The result will be efficient. Do you agree or disagree, explain your answer